Recently, the Prime Minister had stated that tax related exemptions need to be removed. The question is how the coming Budget will tackle the sensitive issue. S Madhavan addresses the matter from an indirect tax standpoint

It has long been the stated intent of the government to increase the tax to GDP ratio. Historically, the tax GDP ratio in India, as regards federal taxes, has been below the double-digit mark and as recently as in 2005, the finance minister had articulated the need to significantly increase this ratio.

The only meaningful way this can be achieved is to increase the revenues from indirect taxes. The job cannot be done by merely addressing direct taxes. Historically again, indirect taxes have contributed majorly to Central government revenues and this fact is unlikely to change any time soon.

Now, if the quantum of federal indirect tax revenues is to significantly grow, in order for the objective of the increased tax to GDP ratio to be achieved, the only feasible way in which this can be done is to broadbase the coverage of indirect taxes, by eliminating exemptions, and to consequently also moderate the tax rates, in order to achieve the twin objectives of a growth in fiscal revenues as also in economic and business output and efficiencies.

Therefore, the economic rationale for removal of exemptions has long been accepted. Indeed, the worldwide experience is to broaden the tax base through large scale removal of exemptions and limiting exemptions to a small and moderate number, to be supported by cogent socio economic arguments.

Given this policy imperative, the coming Budget would clearly undertake significant initiatives on removals of exemptions. The reason why this is expected this year is that such hard decisions can typically be taken only some years away from the general elections, which are due in 2009, and hence 2007 is indeed the right time, from this standpoint.

On Customs, the present fairly long list of end use-based exemptions is expected to be significantly pruned. However, India has also progressively and consistently reduced duty rates and this ongoing exercise, which was manifest in the duty cuts effected on January 22, will result in the emergence of a moderate Customs duty regime, similar to the ASEAN model.

It is, of course, also true that not all exemptions will be discontinued and there will always continue to be a limited set of goods which will be eligible for an exemption from Customs duties. These products will typically relate to our international commitments, such as on IT products, or those which are required to provide medical care and possibly those goods which are not manufactured indigenously or are predominately imported for every day mass consumption.

On the excise front, the discussion on exemptions is focussed around product-related and area-related exemptions. The point relating to Customs duty exemptions is equally relevant for product related excise exemptions and there is a similar expectation that the list of product related exemptions will be significantly reduced in the Budget.

However, the more important point is that area-related exemptions, such as those applicable to J&K, HP, Uttaranchal and the North East States, will most likely remain untouched in this years Budget since it was only very recently that these exemptions, which were originally scheduled to be in force up to March 31 2007, were extended by another three years.

Indeed, a majority of the investments in various product categories of general consumption, such as FMCG, are precisely in these excise-free zones. So, it is likely that Budget tackle product-related exemptions in Customs and excise, while it will leave untouched the very significant area-based exemptions from excise.

If India has to keep its tryst with the goods and services tax by 2010, as has been mooted by the finance minister last year, it is imperative that exemptions of any kind are significantly eliminated so that all economic activity in the country, whether it be the supply of goods or the provision of services, is charged to a moderate indirect tax. It is expected that Budget 2007 will significantly advance this progression to the GST.

The author is leader-indirect tax practice, PwC